Chapter 21 The law of insolvency (LQ) Exam Questions with Complete Solutions.

Chapter 21: The law of insolvency (LQ) Exam Questions with Complete Solutions Steven owes Thandi, Joseph and SARS money. Steven gave Thandi a valuable painting to keep until he has fully paid the debt. They agreed that if Steven did not pay Thandi she could sell the painting to recover the debt that Steven owes her. Steven owes SARS R5 000 in arrear taxes. Joseph painted Steven's house and Steven still owes him R1 000 for the job. Assume Steven is then declared insolvent. Briefly explain how the trustee will deal with each of these creditors and their claims. - Correct Answers: · Thandi is a secured creditor as the painting serves as real security for her claim. (1) Thandi will be paid first from the proceeds of the painting once it has been sold. If any balance is left over after the secured creditor has been paid, this will form part of the free residue. (1) · SARS is a preferent creditor, as this claim will enjoy preference over other claims according the order of preference as set out in the Insolvency Act. (1) SARS will then be paid first from the free residue after the secured creditors have been paid. (1) · Joseph is a concurrent or ordinary creditor and will be paid out if there is sufficient free residue to extinguish the preferential claims. (1) "Creditors must prove to the court that they qualify to apply for compulsory sequestration." List the requirements that creditors must prove before a court will grant a compulsory sequestration order. - Correct Answers: · Creditors must prove that they qualify to apply for compulsory sequestration · The debtor must have committed an act of insolvency · There must be reason to believe that the granting of the order will be to the advantage of creditors. George was declared insolvent by the Court on 1 November 2013. Indicate how the trustee will deal with each of the following: George successfully sued for compensation for pain and suffering when he was injured in a motor vehicle accident 2 years ago.The money was paid into his account on 8 October 2013. - Correct Answers: The Act automatically excludes certain property of the insolvent from the insolvent estate. (1) Compensation for loss suffered in the insolvent's personal capacity will be excluded. This will include compensation for pain and suffering. (1) George is currently employed and earns a salary of R52 000 per month. - Correct Answers: Remuneration for work done by the insolvent after sequestration is excluded from the insolvent estate (1) But the trustee may lay claim to that part of the remuneration that is not needed for the support of the insolvent or his dependents (1) On 7 September 2013, George gave his car to his mother to thank her for paying for his education. - Correct Answers: This donation constitutes an impeachable disposition in the form of a disposition not made for value. (1) This donation can be set aside by the trustee (1) to the extent that, immediately after the disposition was made, the insolvent's liabilities exceeded his assets. (1) (Therefore, if the amount by which the liabilities exceeded the assets is less than the value of the disposition, then the disposition will be set aside partially.) On 1 October 2013, George asked his sister-in-law to keep his new BMW at her house because he didn't want his creditors to get their hands on his car. - Correct Answers: This may constitute an impeachable disposition in the form of a collusive disposition (½) If, at any time before sequestration, the insolvent, in collusion with another, disposed of property in a manner which prejudiced creditors (1) The disposition may be set aside (½) The colluding party would be liable to make good any loss caused to the insolvent estate and pay a penalty (1) Joseph is a wealthy businessman who operates his own business. He spends R2 million on works of art, which he then donates to a museum. Another R8 million is put into his pension fund, and the remaining R30 million is given to his wife, to whom he is married out of community of property. He owes R60 million and is declared insolvent. Creditors demand to be paid. Advise the trustee. - Correct Answers: The R2m spent on works of art then donated to museum: This is a disposition not made for value, in the form of a donation. The disposition may be set aside to the extent that, immediately after the disposition was made, the insolvent's liabilities exceeded his assets. (2) The R8m into the pension fund: While the effect of the sequestration is that the estate of the insolvent vests in the trustee, certain property will be automatically excluded from the insolvent estate. Pension monies will be excluded from the insolvent estate and will therefore not be available for the benefit of creditors. (2) The R30m given to his wife: When the insolvent spouse's estate is sequestrated, all the property of the solvent spouse also vests in the trustee.The solvent spouse must apply for the release of her property.The solvent spouse will have to prove that she acquired the money with valid title against the creditors of the insolvent spouse.She will not be successful in this regard. (2) John was declared insolvent by the Court on 15 September 2014. John is married out of community of property to Mary. Briefly explain how the trustee will deal with each of the following: 1. John is currently employed and earns a salary of R60 000 per month. - Correct Answers: Remuneration for work done by the insolvent after sequestration is excluded from the insolvent estate (1) But the trustee may lay claim to that part of the remuneration that is not needed for the support of the insolvent or his dependents (1) On 15 June 2014, John donated a computer valued at R20 000 to the Reach for a Dream Foundation. - Correct Answers: This donation constitutes an impeachable disposition in the form of a disposition not made for value. (1) This donation can be set aside by the trustee (1) to the extent that, immediately after the disposition was made, the insolvent's liabilities exceeded his assets. (1) (Therefore, if the amount by which the liabilities exceeded the assets is less than the value of the disposition, then the disposition will be set aside partially.) On 2 September 2014, John, realizing he was not able to pay all his debts, gave his Rolex watch to his brother to whom he owed R50 000 in order to set off this debt. - Correct Answers: This can constitute an impeachable disposition in the form of an undue preference (½) Where, at any time before sequestration, the debtor disposes of property at a time when his liabilities exceed his assets (1), with the intention of preferring 1 creditor over another (1) The court may set the disposition aside (½) Mary's estate to the value of R800 000. - Correct Answers: When the insolvent spouse's estate is sequestrated, all the property of the solvent spouse also vests in the Master, then the Trustee (1) The solvent spouse must apply to the Trustee or court for the release of her property. (1) Draw up a comparison of the three requirements for voluntary surrender and compulsory sequestration in a table. The third requirement for each process makes reference to 'advantage to creditors'. But, under voluntary surrender, the debtor must prove that sequestration 'will be' to the advantage of creditors whereas, under compulsory sequestration, the creditor/s must prove that there is 'reason to believe' that sequestration will be to the advantage of creditors. Which requirement is the stricter one? What do you think is the reason for the different wording of this third requirement under each process? - Correct Answers: Under voluntary surrender: 1. The debtor's estate is insolvent. 2. There is realisable property of sufficient value to cover the costs of sequestration. 3. There will be an advantage to creditors. Compulsory sequestration: 1. The creditor must establish a claim under Section 9(1). 2. The debtor committed an act of insolvency. 3. There is reason to believe that sequestration will be to the advantage of the creditors. The requirement for advantage to creditors is stricter under voluntary surrender than under compulsory sequestration. Possible reasons include that the debtor has direct access to his own financial records and is therefore in a prime position to prove that there will, in fact, be advantage to creditors. The law of insolvency has a negative impact on the spouse of the debtor, whether they are married in or out of community of property. Compare and contrast the legal position of a spouse who is married to the debtor in community of property to that of a spouse who is married to the debtor out of community of property. Do you think it is fair that the law of insolvency has such a harsh impact on the legal position of the spouse? What are the reasons for your answer? - Correct Answers: The spouse married to the debtor in community of property has a joint estate with the debtor, and she will therefore also be sequestrated along with the debtor. The spouse married out of community of property has a separate estate from that of the debtor. However, the Insolvency Act allows for the vesting of her property in the trustee. Yes, it is fair for this to happen as this allows the trustee to properly evaluate whether there has been any collusion between the spouses. The vesting is temporary and the Act does allow the spouse to apply for the property to be released. What are the requirements for the voluntary surrender of a debtor's estate? - Correct Answers: 1. The debtor's estate is insolvent 2. There is realizable property of sufficient value to cover the costs of sequestration. 3. Advantage to creditors. What are the requirements for the compulsory sequestration of a debtor's estate? - Correct Answers: 1. The creditor must establish a claim under Section 9(1). 2. The debtor committed an act of insolvency. 3. There is reason to believe that sequestration will be to the advantage of the creditors. What is a friendly sequestration? - Correct Answers: This is when the application for compulsory sequestration is brought by someone who is not at arm's length to the debtor - for example, a family member. Critically analyse the meaning of 'spouse' in insolvency law. - Correct Answers: This refers to the legal spouse. It needs to be inclusive of all types of relationships and contexts. Who qualifies as a debtor? - Correct Answers: A debtor is a person who owes money to someone else, a creditor. Under South African law, the following persons qualify as debtors: ● a natural person ● a deceased person ● a person incapable of handling his own affairs ● a trust ● a partnership ● certain companies. Compare the powers and duties of the trustee and the liquidator. - Correct Answers: The trustee is tasked with collecting and preserving assets in the insolvent estate with the aim of realising those assets for the benefit of the creditors. To this end, the trustee has the following powers and duties: ● Take possession and control of all movable property, books and documents (including electronic records) that belong to the insolvent estate. ● Get the property appraised and furnish the Master with a valuation thereof. ● Call upon debtors to the insolvent estate to pay their debts within a specified date at a specified place. ● Temporarily carry on the insolvent's business, but only if authorised by the Master to do so. ● Investigate the insolvent's financial affairs in order to report to the creditors. ● Open a receipt book to record all money, goods and documents that she receives, and make it available for inspection by the Master and any interested party. ● Open a cheque account in the insolvent estate's name, and deposit all monies received. ● Submit a full written report on the insolvent's financial affairs to the creditors. ● Enlist the services of a legal practitioner, if necessary. ● Refer a dispute regarding the insolvent estate to arbitration with the authorisation of the creditors, or the Master if there is no creditor who has proven a claim as yet. The primary functions of a liquidator are to take custody of all property that belongs to the company, to realise that property, to use the proceeds to pay the costs of the process and the creditors, and to share the balance among the shareholders. In carrying out these functions, the liquidator must bear in mind that he has a general fiduciary duty towards the company, its members and the creditors. The specific statutory duties of the liquidator are as follows: ● Provide relevant information to the Master. ● Keep proper records of all prope Who is disqualified as a trustee and as a liquidator? - Correct Answers: The following persons are disqualified from occupying the position of a trustee: ● an insolvent person ● a person who is within certain degrees of relationship to the insolvent - for example, a close family member ● a minor or other person with legal disability, for example, a mentally-ill person ● a person who resides outside the country ● a person who has a conflicting interest to that of the general interest of the creditors ● a former trustee who was disqualified under Section 72 - that is, for the unlawful retention of money, or use of property in the insolvent estate ● a person who is disqualified to be elected as trustee under Section 59 - that is, for a reason related to misconduct in an office of trust ● a corporate body ● a person who has been convicted, whether in the country or elsewhere, of theft, fraud, forgery or perjury, and has been sentenced to imprisonment without the option of a fine, or to a fine exceeding R2 000 ● a person who was at any time a party to an agreement with a debtor or a creditor whereby she undertook that she would, in her position of trustee, grant or obtain a benefit for a debtor or creditor that was not provided for by law ● a person who has by means of misrepresentation, reward, or the offer of a reward, whether direct or indirect, induced or attempted to induce a person to vote for her as trustee or to assist in having her elected as trustee ● a person who acted as the bookkeeper, accountant or auditor of the insolvent estate during a twelve month period before sequestration ● any agent authorised specially or under a general power of attorney to vote for or on behalf of a creditor at a meeting of creditors of the estate concerned and acting or purporting to act under such authority. Who cannot be a liquidator? The following persons are disqualified from being appointed as a List the instances in which a trustee and a liquidator be removed from office. - Correct Answers: A trustee must vacate her office in the following instances: ● if her own estate is being sequestrated ● if she has been declared incapable of managing her own affairs by a court, or an order is issued under the law on mental health for her detention at a mental institution ● if she is convicted of any offence and sentenced to serve any terms of imprisonment without the option of a fine, or if she is convicted, whether in the country or elsewhere, of fraud, theft, forgery or uttering a forged document, or perjury. Removal of the trustee from office The Insolvency Act also provides that the Master may remove a trustee from her office in the following instances: ● The trustee was not qualified for election or appointment as trustee, or that her election or appointment was illegal, or that she has become disqualified. ● The trustee failed to perform any of her duties satisfactorily or to comply with a lawful demand by the Master. ● The trustee is mentally or physically incapable of performing her duties satisfactorily. ● The majority of creditors who are entitled to vote has requested her in writing to step down. ● In the Master's opinion, the trustee is no longer suitable to be trustee of the insolvent estate. Removal of the liquidator from office The Master may remove a liquidator from office in the following instances: ● The liquidator was not qualified, or his nomination or appointment was illegal, or that he has become disqualified from being a liquidator. ● The liquidator failed to perform a statutory duty satisfactorily or to comply with a lawful demand of the Master or a commissioner appointed by the court. ● The liquidator's estate has become insolvent or he has become mentally or physically incapable of satisfactorily performing his duties. ● The majority in number and in value of creditors who are entitled Discuss the significance of the ranking of the creditors in insolvency law. - Correct Answers: The creditors are ranked according to the nature of their debt, and this ranking determines the order in which they get paid as well as the amount. Outline the ways in which the interests of the creditors are protected in insolvency law. - Correct Answers: The entire Insolvency Act aims to protect the interests of the creditors, for example, the requirements, the procedures and the ranking. What is the purpose of a provisional order of sequestration? - Correct Answers: This allows any interested party an opportunity to object to the issuing of a final order of sequestration. It also gives the creditors a legal remedy for preserving the debtor's estate. The court, after examining all the relevant documents that are before it, also has the option of dismissing the application for compulsory sequestration, postponing the hearing, or any other order that it deems fit. Distinguish between a compromise and a composition in insolvency law. - Correct Answers: If an insolvent has been provisionally sequestrated (or before), the insolvent may enter into a written agreement with his creditors and the trustee (if a provisional trustee has been appointed) to pay a certain amount on his debts on condition that the provisional order of sequestration is discharged. This is a common law compromise, and it requires consent from all the creditors. Section 119 of the Insolvency Act allows for an insolvent, whose estate has been finally sequestrated, to avoid some of the effects of sequestration and shorten his period of insolvency by entering into a statutory composition with his creditors. Here, if the majority of the creditors accept the insolvent's offer of payment, the minority of the creditors are also bound by this acceptance. If the offer of composition is not less than 50 cents in the rand for every concurrent claim, then the insolvent has the advantage of applying to court for early rehabilitation (discussed below). When can an insolvent apply to court for rehabilitation? - Correct Answers: Section 124 of the Insolvency Act sets out the circumstances in which the insolvent may apply to court to be rehabilitated before the period of ten years from the date of sequestration has passed. These circumstances are as follows: ● The insolvent has obtained a certificate from the Master that the creditors have accepted an offer of composition of not less than 50 cents in the rand for every concurrent claim. ● Lapse of the prescribed period after confirmation by the Master of the first account in the estate. Here, the Act sets out various prescribed time periods depending on the circumstances and conduct of the insolvent. For example, if the insolvent has been convicted of a fraudulent act in relation to his insolvency, then he may only apply for rehabilitation after five years have passed from the date of his conviction. ● No claims have been proved against the insolvent estate after six months, the insolvent has not been convicted of any fraudulent acts in relation to his insolvency or any offence under the Act, or his estate has not been sequestrated before. ● The Master has confirmed a plan of distribution providing for the full payment of all proved claims with interest and all the costs of sequestration. The Insolvency Act comprehensively sets out the procedures and preliminary steps to be followed for an application for rehabilitation. The court bears a discretion on whether or not to grant the rehabilitation order. Discuss the role of the Master during sequestration and the winding-up processes. - Correct Answers: The Master has an important role to play in every stage of the administration of insolvent estates and the winding up processes of companies and close corporations, from the launching of the sequestration or liquidation processes to applications for rehabilitation of the insolvent or deregistration of corporate entities. The Master is appointed under the Administration of Estates Act 66 of 1965 to each of the areas of the provincial divisions of the High Court, and has extensive and specialised powers in terms of this Act. We say that the Master is a creature of statute in that he is created by statute, his powers are limited by those given to him by the legislature, and he cannot act unless he is empowered by to do so by statute. If a party is dissatisfied with a decision or order that is made by the Master, she may bring it under review by the court and may bring an application to court. Compare the effects of a sequestration order and a winding-up order. (1/2) - Correct Answers: The effects of sequestration 1. The legal position of the insolvent: Insolvency has an impact on the insolvent's contractual capacity in that there are certain restrictions placed on the insolvent's capacity to contract. Students should refer back to this chapter to refresh their memories on this section. The insolvent is also prohibited from holding a number of positions, including the following: ● trustee in an insolvent estate ● a director of a company unless the court grants an exemption ● management of a close corporation unless the court grants permission ● a business rescue practitioner ● a trader who is a general dealer or manufacturer ● a distributor of liquor ● a member of the National Assembly, National Council of Provinces or provincial legislature ● a practising attorney unless he can prove that he is still a fit and proper person ● a registered credit provider ● a member of the governing board of the National Credit Regulator. 2. The insolvent's estate: One of the main effects of sequestration is that the insolvent's estate first vests in the Master and thereafter in the trustee, once a trustee has been appointed. This then enables the trustee to carry out her duties of collecting assets that belong to the estate, realising those assets and paying creditors. Generally, the following property does not vest in the trustee: ● clothes, bedding and other means of subsistence, such as furniture ● payment for work done (except for that portion which is not needed for subsistence, which is payable to the trustee upon the Master's determination) ● pension ● compensation arising from a claim for defamation, personal injury or occupational injuries or diseases ● unemployment insurance benefits ● certain insurance policies, such as life policies ● trust money and property ● the insolvent's share in accrual, wher Compare the effects of a sequestration order and a winding-up order. (2/2) - Correct Answers: The effects of winding-up The effects of winding-up a company are as follows: ● The winding-up by the court (of an insolvent company) is deemed to commence at the time of the presentation to the court of the application for the winding-up - that is, when the relevant documents are lodged with the registrar of the court. ● The directors are divested of their powers. ● The Master takes control of the company's property until a liquidator is appointed. ● The business of the company may only continue in so far as it is necessary for the winding-up. ● If the company is unable to pay its debts, its dispositions of property must be authorised by the court. Otherwise, those dispositions will be void. ● Any transfer of the company's shares must be authorised by the liquidator. Otherwise, that transfer will be void. ● All civil proceedings by or against the company are stayed until a liquidator is appointed. ● Once the Master receives the winding-up order, he must give notice of it in the Gazette. ● The registrar must serve a copy to all relevant persons - for instance, certain sheriffs, the Registrar of Deeds, registered trade unions, employees, and the South African Revenue Services. ● If the court made a winding-up order, the directors and officers of the company must prepare and lodge a statement of affairs of the company with the Master within fourteen days of the date of the winding-up order. ● Once a company is wound up, the Companies and Intellectual Property Commission makes a record that the company is no longer in existence (dissolved and deregistered), and it publishes a notice of this information. What types of property of the insolvent do not vest in the trustee? - Correct Answers: Clothing, bedding, furniture for subsistence, remuneration for work done (subject to exceptions), pension, compensation for defamation or personal injury, compensation for occupational injuries or diseases, benefits payable to a minor, unemployment insurance benefits, certain insurance policies, a share in accrual in terms of matrimonial property, trust funds and property, a right of a labour tenant to land, and property acquired with money from any of the above sources. When can a company be wound up by the court? - Correct Answers: Section 344 of the 1973 Act and Section 81(1) of the 2008 Act set out the grounds for winding-up an insolvent and solvent company respectively. These grounds include the following: ● A special resolution to wind up the company (solvent or insolvent company) has been passed. ● The company has not commenced business within a year of incorporation or if it has suspended business for a year (insolvent company). ● 75% of the company's share capital has been lost or become useless (insolvent company). ● The company is unable to pay its debts, subject to certain provisions (insolvent company). ● An external company may be wound up if it has been dissolved in the country in which it was incorporated, or has ceased to carry on business, or is carrying on business only for the purpose of winding up its affairs (insolvent company). ● It is just and equitable to wind up the company (solvent or insolvent companies), for instance, if the objective for forming the company is no longer possible; the company's objectives are illegal; there is a justifiable lack of confidence in the management of the company; the voting power in the company is divided, or when the minority shareholders are being oppressed by the controlling shareholders. ● The company is in business rescue and there is no reasonable prospect of the company being rescued (insolvent company). ● The directors, officers or other persons in control of the company are acting in a manner that is fraudulent or illegal. ● The company's assets are being misused or wasted. ● The company has failed to comply with a compliance notice that was issued by the Companies and Intellectual Property Commission or Takeover Regulation Panel in the case where the directors, officers or other persons controlling the company have acted fraudulently or illegally How is a sequestration order set aside? - Correct Answers: A person who is dissatisfied with the court's decision to grant a final order of sequestration, or by the court's decision to set aside an order of provisional sequestration, may lodge an appeal. How is a winding-up order set aside? - Correct Answers: A creditor, member or even the liquidator may bring an application to court to stay or set aside the proceedings. What is business rescue, and why is it a desirable option to a company that is in financial trouble? - Correct Answers: When a company is in financial distress, business rescue serves as one of two alternatives to winding-up. The other alternative to the company is to reach a compromise with its creditors. The aim of business rescue is for the business rescue practitioner to help the company out of its financial distress by facilitating its rehabilitation through the following: ● the drafting and implantation of a business rescue plan ● the temporary suspension of the rights of claimants against the company ● the temporary supervision of the company and its affairs. While court will favour business rescue over winding-up, it will be alert to the possible abuse of business rescue proceedings where it is used to simply keep the creditors at bay, instead of rescuing the business. The process may commence in the following ways: ● The board of directors adopts a resolution to this effect (voluntary business rescue). ● An order of court (compulsory business rescue). What are the effects of business rescue? - Correct Answers: ● There is a stay on any legal proceedings against the company. ● Property may only be disposed of in very limited instances, for example, if it is the ordinary course of business to do so. ● Employment contracts with employees generally continue as they were before proceedings began. ● The business rescue practitioner may suspend any contract that the company was a party to before proceedings began. ● The business rescue practitioner has the power to exercise full control over the company. ● Each director must continue her functions as such, subject to the instructions of the business rescue practitioner.